Mutual Fund Site

The Fidelity Small Cap Discovery Fund (FSCRX) is an aggressive small cap mutual fund made up of mostly small cap securities (70.81%) with some assets invested in micro cap (15.75%) and even less in medium cap. As far as mutual funds go, Fidelity has been a steady performer even though their risk is marginally above average compared to other mutual funds in its category.

The security composition is mostly value but since 2009, they have shifted to more of a blended approach. As a result, this small cap mutual fund has been able to outperform the index in 4 of the past 5 years (failing in 2008 miserably), as well as the category (also failing in 2008).

Given its strong and steady performance, the Fidelity Small Cap Discovery fund has been a favorite over at Morningstar, achieving a 5-star rating in all categories except ten years since it has not been around quite that long.

In terms of the fund’s composition, there are just 52 holdings in total. This is where investors will either take comfort or become unsettled, the fund’s top listed sector is the Financial Services Sector, with 21.9% of its holdings in this group. This group has clearly been instrumental in providing great returns recently, with a YTD return (as at May 12, 2010) of 18.98% versus just 5.44% for the category and 13.17% for the Index.

Strong returns — YTD of 18.98% beat the Index by more than 40% and kill the Category by nearly 250%

The Mutual Fund Site likes its top holdings — it became something of a challenge when it came time to deciding which top holdings to look at most closely. This is partially the result of the fund not taking an obvious bias toward any given top holding; the risk is spread expertly among its top 10 holdings. This, of course, makes for a good thing in terms of asset allocation.

Since we are mostly bullish on the Financial Services sector, we chose the top, 3rd and 5th largest holdings.

1. Meritage Homes Corporation (MTH) at 2.86%
As a homebuilder, Meritage had its shares of problems, adjusting poorly to the changes in homebuilding that began in 2007 and up until 2010 was extremely challenging. However, with the real estate markets starting to show signs of bottoming out, Meritage seems poised to make great strides. Thus far, it has contributed impressive returns of 24.42% YTD to the portfolio.

Meritage operates in those higher risk areas of California, Arizona, Texas, Nevada, Colorado and Florida. Although they have reduced their home prices over the past few years, the company is still facing an uphill battle (in our opinion) with shrinking revenues, systemic problems in some of its largest markets as well as its overall size.

However, the company remains solvent with a decent equity position, and the financials have been very well managed over the years with expense management allowing for a considerable improvement to net income in 2009 over 2008 despite gross revenues shrinking by nearly 40%.

Fidelity likes this company, holding nearly 4.8% of it in another fund. T. Rowe Price, owns a over 6% between two o its funds.

And of course, the Mutual Fund Site believes that this homebuilder will indeed profit well once the housing market turns around. With its good equity base, ability to generate cash flow, this is clearly a smart homebuilder to own, despite the current-day risks.

2. RTI International Metals (RTI) at 2.83%
As a Titanium-mill and other specialty metals producer, RTI is an interest small cap play. With $410 million in sales, it does not compare equally to larger players like, say, Rio Tinto, but the company is fairly well managed and should perform well in the medium term.

In terms of revenue diversification, RTI is heavily involved in aerospace, defense and energy. Each of these sectors is heavily dependent on private and government funding, which may account for some of its poor revenue showings in the past 3 years.

Problems facing RTI include negative growth over the past 3 years. With such a higher concentration on sectors that depend on government funding, RTI could be one of the larger risks in the portfolio, yet to date it has already returned 3.62%. As well, in 2008 it was voted as one of the 100 fastest companies in the US.

Analysts are also bullish on this stock, declaring it a buy.

3. Wesco International Inc. (WCC) at 2.79%
A distributor of electrical supplies, Wesco is his heavily involved in construction (36%) and industrial (40%) sectors. Unlike many of its competitors, its reliance on utility sales (17%) is muted compared to the private sector, positioning Wesco to gain from a construction and manufacturing turn around, a true value play.

In addition to its strong positioning in the market, Wesco has contributed 46.7% on a YTD basis to the funds overall returns. This has not gone without notice; 16 analysts covering this stock have progressively ranked it as more of a buy over the past year.

Financially, Wesco remains in a strong equity position despite falling sales and a tighter market, yet it continues to generate cash on a year-over-year and quarter-over-quarter basis. Clearly, this is a sign of strict and disciplined management.

Risks facing the security include negative sales growth over the past 3 years. Of course, this is not uncommon given its concentration on the construction and industrial sectors, which have also been hammered but which, on the whole, are showing positive signs of recovery.

For investors with the Risk Tolerance, Fidelity Small Cap Discovery makes good sense.

Overall, we like this small cap mutual fund. It performs well and, despite the higher risk rating, its holdings position the fund to enjoy fairly substantial gains during the upcoming years of economic recovery and expansion. While flaws can be found in virtually all of its top 25 holdings, those threats or weaknesses also present the most compelling opportunities.